Chapter 20, Problem 1LO

To determine

Working of foreign exchange market and importance of the exchange rate.

Explanation of Solution

The demand and supply of currency determines the exchange rate in foreign exchange market. The appreciation and depreciation of currency is affected by the demand and the supply of the currency.

If the supply of foreign currency exceeds the demand of foreign currency, in comparison to domestic currency, then it results in depreciation of currency. Whereas if the demand of foreign currency exceeds the supply of foreign currency, in comparison to domestic currency then, it results in appreciation of currency. The exchange rate of foreign currency is determined where the demand of foreign currency equals to supply of foreign currency.

The determination of exchange rate is very important as the relative economic health of a country is determined by the exchange rate of the country’s currency. Various important factors are also influenced by the exchange rate; these factors are inflation in the economy, interest rate and capital gains.

Economics Concept Introduction

Introduction:

The market in which buying and selling of currencies are exchanged is referred to as the foreign exchange market. Number of financial intermediaries can participate in this market like commercial banks, central banks, individuals, commercial companies, foreign exchange brokers.